removal of deductions gives ample scope for a tax cut

Kitty Miv, Editor07 March, 2016

Kitty's Country Rankings are below, with a description of how they are compiled. This week, as every week, I give out Encomiums to countries which have done Good Things, and award Execrations for countries which according to my highly personal and partial views have done Bad Things.

I do sympathize with governments sometimes (although admittedly not very often), as there seem to be occasions when they just can't win. They're constantly being told by the likes of the OECD and the IMF to eradicate special tax regimes, widen their tax bases, reduce income taxes where possible, and shift the tax burden onto consumption. Luxembourg is one country doing just that. Last year, the Government decided to phase out its patent box regime – exactly the sort of special tax regime the OECD sees as largely responsible for BEPS – and late last month it announced reductions in income tax for companies and low- and middle-income workers. These measures come after a 2 percent increase in the standard rate of value-added tax in 2015. Yet, according to the IMF, this is still wrong: "The tax cuts are too deep, the tax base is too narrow, you'll use up all your fiscal surpluses if you do that!" it bleated in its latest Article IV report. I paraphrase, of course.

Not that the IMF's recommendations are binding; it's up to Luxembourg to do what it sees fit with its surplus in my view, and any other country not receiving assistance from the Fund for that matter. And anyway, what's the point of these Article IV consultations, because they seem to be routinely ignored. Yet, every country gets the Article IV treatment at some point, usually annually or bi-annually. That's a lot of analysts' and economists' time, a lot of air miles, and a lot of money!

Not as much money as the US Government theoretically "spends" on individual income tax deductions though, I would have thought. That's equal to USD1 trillion per year, says the Tax Foundation, and that's just for the three major tax expenditures: the state and local tax deduction; the charitable contributions deduction; and the mortgage interest deduction. That's almost as much as the Internal Revenue Service collected in personal income tax receipts alone in 2014, which was just under USD1.4 trillion, according to the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution. You can probably guess where I'm going with this!

So, if these three personal income tax deductions were abolished, that would result in an almost 60 percent increase in personal income tax revenues, and dramatically simplify the individual tax code to boot. It must also be hugely expensive and time consuming for the IRS and taxpayers to administer these deductions. Of course, such a course of action would be extremely unpopular, so you'd have to cut federal income tax by an equivalent amount. That means instead of a top rate of tax of nearly 40 percent, the US could have a maximum rate in the mid-20s percent. Okay, it might be a simplistic equation, but it illustrates how taxpayers "pay" for their tax deductions through high rates of income tax, and that the removal of such deductions gives ample scope for a substantial tax cut. Many legislators and aspiring US presidents agree, and most of the current presidential candidates have proposed to do away with at least some personal tax expenditures in their campaign manifestos. However, while such proposals sound good on paper, and on the hustings, perhaps ultimately people are too attached to their cherished deductions now. It's going to take a brave politician to take them away, even if he or she cuts tax at the same time.

Another nation where tax deductions seem to have gotten out of hand is India. But I'm not quite sure what to make of the 2016 Union Budget, announced recently by Finance Minister Arun Jaitley, which, supposedly, is a continuation of the Government's campaign to simplify India's nightmarish tax code. There's certainly some interesting proposals in there, not least the new patent box regime, which seems to have come out of left field, especially as these days patent boxes are rather frowned upon by the arbiters of right and wrong in international taxation (i.e. the OECD and the EU). And I can see how a patent box regime would fit with the BJP Government's modernization agenda, as it attempts the difficult transition from a low-value manufacturing economy to a high-value-added "knowledge" type economy. But perhaps a patent box isn't a priority for India right now. Would such a thing be sufficient to attract hi-tech firms to India given that the rest of the tax system is such a shambles?

A phrase Jaitley is fond of using is "ease of doing business." India must, he says, improve its ease of doing business. And he's right. The World Banks's 2016 ease of doing business index ranks India 130th out of 189 jurisdictions. If you can believe it, that's one place behind the West Bank and Gaza Strip. India's ease of paying taxes ranking is even worse: 157th. Whether a true reflection of the situation or not, these ratings nevertheless give some indication of the colossal task at hand, and perhaps it might be beyond the reformist credentials of Prime Minister Modi. It's easy for me to say of course, for governing India must feel like trying to change the course of a super-tanker at full speed with a defective rudder. But maybe Jaitley should be looking at the basics. If you're trying to repair a weak structure, strengthening the foundations might be a good place to start, rather than the addition of a new extension.

You're probably not going to be too concerned with the interior décor of a building you're attempting to save from crumbling. But, to switch subjects, if you've ever asked your sulky teenage offspring, for about the 100th time that week naturally, to tidy his or her room, you might be familiar with the refrain "I didn't ask to be born!". Likewise, Gibraltar didn't ask to be a British possession perched on a rock in southern Spain, but it is, and has been for the last 300 years. However, Spain just refuses to accept it.

Actually, it's very unfair of me to compare Gibraltar to a hormone-fueled adolescent with a persecution complex. Of the two parties, the "Rock" that appears to be the mature one, and Spain the obstreperous child. Because, for a supposedly "mature" nation itself, Spain hasn't exactly covered itself in glory with its recent treatment of its tiny neighbor. It has hectored Gibraltar in all sorts of ways short of sending in troops, making life for its inhabitants about as uncomfortable as it possibly could. And this is because it resents having a British "tax haven" on its door step, and would rather like Gibraltar back. I suppose the thinking behind this is that once it's back in Spanish hands, the harassment will stop – although these tactics have hardly endeared the population of Gibraltar to Spain's cause. Quite the reverse in fact. In a sovereignty referendum in 2002, 98.5 percent of the electorate voted for the status quo.

I'm mentioning this subject this week because Spain has long accused Gibraltar of being a hive of money-laundering and tax evasion, and Gibraltar was once again forced to defend itself, quite robustly, recently in the face of what Deputy Chief Minister Joseph Garcia termed "ignorant and unsubstantiated" criticism of the territory from a Spanish MEP. A low-tax jurisdiction it might be. You might even call it a tax haven. But a haven for dirty money? As a member of the EU, it is obliged to have all the relevant EU financial regulations in place, and Brussels simply isn't going to tolerate the presence of a rogue jurisdiction in its backyard. But still the allegations and insinuations come.

However, I'd like to know why Madrid hasn't replied to Gibraltar's request to sign a bilateral tax information exchange agreement though. It's almost as if it's useful for the Spanish Government to have Gibraltar in reserve so it can bash it when things aren't going right for it. And another pertinent question: if Britain must give Gibraltar back to Spain, then shouldn't Spain give Ceuta and Melilla back to Morocco? The silence in Madrid is deafening. Some might not like it, but Gibraltar deserves an encomium for quietly going about the business of building a successful, modern economy.

Kitty's Encomiums and Execrations

Methodology: each week (this is the 147th) one or more countries are given encomiums and one or more are given execrations. Those are the entries below with descriptive links. In the following week, each encomium counts as + 1 for that country, and each execration counts as – 1, being added to that country's existing score. Over time, therefore, a ranking will build up for each country, and further countries will join the listing. Germany is at minus 2, since in the second week it had an execration and in the first week it had an encomium, leaving it at neutral; then it had an execration in week four, thus dropping to – 1, and another one in week six, dropping to – 2; finally in week 13 it got something right, so it went back up to – 1; then in week 16 it gained a further star, so then it was in neutral territory until week 23 when it dropped back to minus one, but reverting to neutral territory in the following week, then dropping to minus one in week 50, and back up to plus one in week 51, then to plus two in week 52. Some weeks ago it dropped a place, but then quickly recovered one step. Etc etc.

The rankings are intended to be a proxy for business friendliness; evidently they are highly partisan, but as time goes by they are becoming useful for decision-making. For any country in negative territory, you should think carefully before starting a business there.

About the Author

Kitty Miv, Editor

Kitty was born in Argentina in 1960 to a Scottish cattle rancher and his Argentine wife. Educated in Edinburgh and at Princeton, Kitty worked for the World Bank as an economist, where she met and married an emigre Iranian banker. During her time with the Bank, Kitty worked in a number of emerging markets, including a spell in the ex-USSR as a Transition Economies Team Leader. Kitty is now a consultant in Brussels and has free-lance writing relationships with a number of prominent economic publications. kitty@lowtax.net

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